Econ 204 week 14 outline b

Prepared By Brock Williams
Chapter 18
International
Trade
and Public Policy
Countries always want to have
foreign markets open for their
exporters. But, if a country limits
access to its own markets, foreign
countries may take action to limit
access to their own markets. The
United States is no exception.

Copyright ©2014 Pearson Education, Inc. All rights reserved. 18-2
Learning Objectives
1. Explain carefully the terms comparative
advantage and terms of trade.
2. List the common protectionist policies.
3. Describe the rationales that have been
offered for protectionist policies.
4. Summarize the history of international
trade agreements.
5. Analyze one recent controversy in trade
policy.

P R I N C I P L E O F O P P O R T U N I T Y C O S T
The opportunity cost of something is what you sacrifice to get it.
18.1 BENEFITS FROM
SPECIALIZATION AND TRADE

► FIGURE 18.1
Production Possibilities Curve
The production possibilities curve
shows the combination of two goods
that can be produced with a nation’s
resources.
For Chipland, the trade-off between
the two goods is one to one.
For Shirtland, the trade-off is three
shirts for every computer chip.
In the absence of trade, Shirtland
can pick point c—28 chips and 24
shirts—and Chipland can pick point f
—60 chips and 60 shirts. 1 All shirts and no chips: point a.
2 All chips and no shirts: point d.
3 Equal division of resources: point
b.
Production Possibilities Curve
18.1 BENEFITS FROM
SPECIALIZATION AND TRADE (cont.)

Comparative Advantage and the Terms of Trade
● terms of trade
The rate at which units of one
product can be exchanged for
units of another product.
18.1 BENEFITS FROM

The Consumption Possibilities Curve
● consumption possibilities
curve
A curve showing the combinations
of two goods that can be
consumed when a nation
specializes in a particular good
and trades with another nation.
18.1 BENEFITS FROM

The Consumption Possibilities Curve
• Given the terms of trade, Chipland can exchange 40 of its120 chips for 80 shirts,
leading to point h. At point h, Chipland can consume 80 chips and 80 shirts.
• Shirtland can exchange 80 of its 108 shirts for 40 chips, leading to point k on its
consumption possibilities curve. Shirtland can consume 28 shirts and 40 chips.
► FIGURE 18.2
Consumption
Possibilities Curve
The consumption
possibilities curve shows
the combinations of
computer chips and shirts
that can be consumed if
each country specializes
and trades.
18.1 BENEFITS FROM

How Free Trade Affects Employment
• Under free trade, each nation will begin to specialize in a single good,
causing considerable changes in the country’s employment in different
industries.
• Switching from self-sufficiency to specialization and trade increases
consumption in both nations, so on average, people in each nation
benefit from free trade.
• But some people in both national will be harmed by free trade.
18.1 BENEFITS FROM

Import Bans
FIGURE 18.3
Effects of an Import Ban
In the free-trade
equilibrium, demand
intersects the total supply
curve at point c, with a
price of $12 and a quantity
of 80 shirts.
If shirt imports are banned,
the equilibrium is shown by
the intersection of the
demand curve and the
domestic supply curve
(point a).
The price increases to $23.
18.2 PROTECTIONIST POLICIES

Quotas and Voluntary Export Restraints
● import quota
A government-imposed limit on the
quantity of a good that can be
imported.
● voluntary export restraint (VER)
A scheme under which an exporting
country voluntarily decreases its
exports.
(cont.)

 FIGURE 18.4
Market Effects of a
Quota, a VER, or a Tariff
An import quota shifts the
supply curve to the left.
The market moves
upward along the demand
curve to point d, which is
between point c (free
trade) and a (an import
ban).
We can reach the same
point with a tariff that
shifts the total supply
curve to the same
position.
(cont.)

● import licenses
Rights, issued by a government, to import goods.
● tariff
A tax on imported goods.
Responses to Protectionist Policies
A restriction on imports is likely to lead to further restrictions on trade.
Many import restrictions have led to retaliatory policies and substantially lessened trade.
The most famous was the Smoot-Hawley Tariff Act of 1930. When the United States
increased its average tariff on imports to 59 percent, its trading partners retaliated with
higher tariffs on U.S. products.
The resulting trade war reduced international trade and deepened the worldwide
depression of the 1930s.
(cont.)

Economists have found that tariffs in the United States fall most heavily on lower-
income consumers.
Footwear accounts for:
• 1.3 percent of the expenditure of lower-income households.
• 0.5 percent of the expenditure of higher-income households.
The highest tariffs fall on the cheapest products—precisely those that will be
purchased by lower-income consumers.
• Low-price sneakers face a 32 percent tariff.
• Expensive track shoes face only a 20 percent tariff.
To protect U.S. industries, tariffs are highest on labor-intensive goods. But these
goods tend to be lower priced. That is why tariffs do fall disproportionately on the
poor.
THE IMPACT OF TARIFFS ON THE POOR
APPLYING THE CONCEPTS #1: Do tariffs (taxes) on
imported goods hurt the poor disproportionately?
A P P L I C A T I O N 1

To Shield Workers from Foreign Competition
● learning by doing
Knowledge and skills workers gain
during production that increase
productivity and lower cost.
● infant industries
Industries that are at an early stage
of development.
To Help Domestic Firms Establish Monopolies in World Markets
To Nurture Infant Industries until They Mature
One of the most basic arguments for protectionism is that it shields workers in
industries that would be hurt by trade.
If the production of a particular good requires extremely large economies of scale,
the world market will support only a few, or perhaps just one, firm.
18.3 WHAT ARE THE RATIONALES FOR
PROTECTIONIST POLICIES?

• Do imports from China really make a difference in U.S. labor markets? Economists David
Autor David Dorn, and Gordon Hanson examined detailed data on Chinese imports into local
communities. Some local communities are more heavily impacted by Chinese imports than
others depending on the mix of products produced locally.
• The authors found that the pace of Chinese import growth was so rapid from 1990 to 2007
that it often had a strong and negative effect on local economies. Those communities that
were more exposed to imports had larger increases in workers receiving unemployment
insurance, food stamps, and disability payments.
• These findings do not mean that trade with China was ultimately beneficial. Displaced
workers can find new jobs and import competition lowers prices for all consumers. But it
does mean that the burden of adjustment to imports varies by region. Some regions will
have a more difficult time adjusting than others to a sudden influx of imports The study also
does not measure the indirect benefits from trade with China. As the Chinese economy
expanded during this period, it created more export opportunities for producers in the United
States. Those benefits were not measured in this study.
CHINESE IMPORTS AND LOCAL ECONOMIES
APPLYING THE CONCEPTS #2: What have been the local
effects of Chinese imports?

● General Agreement on Tariffs and Trade (GATT)
An international agreement established in 1947 that
has lowered trade barriers between the United States
and other nations.
● World Trade Organization (WTO)
An organization established in 1995 that oversees
GATT and other international trade agreements,
resolves trade disputes, and holds forums for
further rounds of trade negotiations.
In addition to the large group of nations in the WTO, other nations have
formed trade associations to lower trade barriers and promote international trade:
• The North American Free Trade Agreement (NAFTA)
• The European Union (EU)
• Asian Pacific Economic Cooperation (APEC)
• Dominican Republic - Central America Free Trade Agreement (DR-CAFTA)
18.4 A BRIEF HISTORY OF INTERNATIONAL
TARIFF AND TRADE AGREEMENTS

● dumping
A situation in which the price a firm charges in a
foreign market is lower than either the price it charges
in its home markets or the production cost.
● price discrimination
The process under which a firm divides consumers
into two or more groups and charges a different price
for each group buying the same product.
Are Foreign Producers Dumping Their Products?
● predatory pricing
A pricing scheme under which a firm decreases the
price to drive rival firms out of business and
increases the price when rival firms leave the market.
18.5 RECENT POLICY DEBATES
AND TRADE AGREEMENTS

• Dumping is selling a product in a foreign market at a lower price than a firm’s
own domestic market. Actual price is rarely used to make this determination.
• The Department of Commerce uses a “constructed value” which estimates what
the value in the home country would be based on production costs,
transportation, and other expenses, plus a margin for profit and administration.
• These are crude and dated estimates that sometimes only have data provided
by the claimant.
• The Commerce Department almost always finds the companies are dumping
their products.
ARE THEY REALLY DUMPING?
APPLYING THE CONCEPTS #3: How does the Commerce
Department try to determine whether countries are dumping
their products?

● outsourcing
Firms producing components of their
goods and services in other countries.
Do Trade Laws Inhibit Environmental Protection?
Do Outsourcing and Trade Cause Income Inequality?
Why Do People Protest Free Trade?
Trade disputes about environmental issues are part of a larger phenomenon that
occurs when trade issues and national regulations collide.
As we have seen in this chapter, trade and specialization provide important
opportunities to raise living standards throughout the globe. But they also mean
individuals and nations surrender some of their independence and sovereignty.
18.5 RECENT POLICY DEBATES
AND TRADE AGREEMENTS (cont.)

Inequality in the United States has increased in the last several decades.
Two economists from the University of Chicago, Christian Broda and John Romalis,
discovered that the prices low-income groups paid for goods and services increased
substantially less than for high-income groups. As a result, living standards have not
become more unequal.
The key to understanding this result is that consumption patterns of the rich and poor
differ.
• The poor consume a higher ratio of nondurable goods to services than the rich,
while prices for nondurable goods have risen less than prices for services.
• Prices for the nondurable goods purchased by the poor also increased less than
the prices of nondurable goods purchased by the rich.
The moral of the story: Trade does not just affect employment patterns—it also
changes prices. We must take both factors into account to understand how living
standards have changed for the rich and poor.
TRADE, CONSUMPTION, AND INEQUALITY
APPLYING THE CONCEPTS #4: Why might international trade
reduce measured inequality in the United States?

consumption possibilities curve
dumping
General Agreement on Tariffs
and Trade (GATT)
import licenses
import quota
infant industries
learning by doing
outsourcing
predatory pricing
price discrimination
tariff
terms of trade
voluntary export restraint (VER)
World Trade Organization
(WTO)
K E Y T E R M S

Econ 204 week 14 outline b

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Econ 204 week 14 outline b